5/15/2000 @ 12:00AM

Waking Dead Capital

THE SHACK ON THE EDGE OF A SEETHING GARBAGE DUMP IN Quezon City, a suburb of Manila, suggests a loan prospect as unreliable as the hovel’s hole-pocked tin roof. But inside, Tarsila Dawisa, 55, has an active business making rattan shelving units. It makes 5,000 Philippine pesos a month, about $125. That pays the electricity bill and buys water and food for her 12 family members, but isn’t enough to get them a decent home away from the smelly, sooty refuse.

“If the government or someone can help me, I need a little more capital,” says Dawisa, sounding–at least in the translated Tagalog–more like an M.B.A. than a gritty grandmother. “We’d increase our volume and be able to supply to exporters. That way we could make 9,000 or 10,000 pesos a month.”

But Dawisa has no practical access to capital. She and her family have been squatting near the government-owned dump for six years; they cannot buy the land.

Impoverished but entrepreneurial, Dawisa is not alone. At a time when untold wealth is reaching all parts of the globe, four-fifths of the world’s 6.1 billion people scrape by, many doing odd jobs or running small businesses.

As more of the world’s poor congregate in cities, they ought to benefit from the specialized division of labor that has fueled growth in industrialized nations. But in many instances poverty just seems to get worse.

One school of thought blames the plight of the poor in the Third World on cultural factors. Something in the work or savings ethic, this theory goes, prevents them from fully developing like their Northern or Western neighbors. In the former communist world, state dependency fostered attitudes seen as discouraging successful enterprise.

There’s another line of thinking: that much of the world has never done capitalism the right way. If it did, poor countries would be a lot richer. Enter Hernando de Soto, a 58-year-old Peruvian economist who made his mark a decade ago with the book The Other Path: The Invisible Revolution in the Third World (FORBES, Jan. 23, 1989). In it he argued that developing countries were poor not because the poor weren’t entrepreneurial, but because they couldn’t get economic oxygen.

The key to doing so, he said, was property rights–and for everyone, not just the elite. With such rights, land title could be leveraged with a mortgage, used as collateral for a bank loan, or sold more easily. If De Soto has his way, poor folks like Dawisa could soon get the access to the capital they wish for.

Licenses are a form of property. In Lima De Soto found that it took 289 days to register a garment shop with one worker, at a cost of $1,230–31 times the monthly minimum wage. To get permission to build a house on state-owned land took six years and 11 months of navigating the bureaucracy and getting papers notarized. For a private bus or jitney driver to obtain official recognition of his route, 26 months.

It’s not that the Peruvian, or any government, sets out to make life hard for its poor people. Rather, inertia and entrenched interests weigh in favor of maintaining the status quo, and ruling elites seldom understand how serious an issue property law is. Says De Soto: “Emancipating people from bad law is a political job.” Without the head of government making such changes a priority, they won’t get pushed through multiple layers of bureaucracy.

Starting in the late 1980s De Soto, with the support of then Peruvian president Alan Garcia and his successor Alberto Fujimori, transformed his theory into action. He talked government agencies and private foundations across the globe into funding (now to the tune of $4 million a year) his Lima-based think tank, the Institute for Liberty & Democracy. With the institute he devised a plan to help Peru’s poor get title to land and businesses more quickly and efficiently. Instead of going through up to 14 different government agencies to obtain a title, poor Lima residents only had to deal with one. The time it took to generate a title was reduced to four months; to register a business, it cost just $12.

Under the guidance of De Soto’s think tank, 300,000 titles were registered in urban Lima from 1991 through 1995. Results were soon palpable. By 1998 the value of the registered urban land had typically doubled; previously nonexistent private mortgage and consumer credit markets had begun to develop.

Politicians in other developing countries took notice. A dozen called De Soto and asked him to come visit and dispense advice. Those calls, and an ideological split with Fujimori in 1993, spurred De Soto to take his “poor people’s capitalism” program on the road. Since 1997 he’s been brought in by the governments of Haiti, Egypt and the Philippines to undertake efforts similar to those in Lima. Other underdeveloped and former communist nations have expressed interest as well. “We’re opening up a new paradigm for which there is no established system of collecting data,” De Soto says of the assessment stage of his efforts. “We’re looking at this from the point of view of the democratization of property rights.”

His findings have proved controversial, but ultimately convincing. “Essentially we’ve been talking about the poor, but we haven’t had a real understanding of who the poor are, what kind of resources they have available, what we can do so they can really participate in the development of the economy and of the country,” says Ronaldo Zamora, executive secretary of the Philippine government. “What De Soto has discovered are things that change our perspective about the whole idea of poverty. The poor are not so poor, for instance.”

Indeed. De Soto estimates that 4 billion poor people in the Third World and former communist nations hold, but don’t legally own, real estate worth $9.3 trillion. That’s 46 times the amount of all World Bank loans made over the past three decades. Without legal ownership, De Soto says, such assets are just dead capital. “These people have houses but not titles, crops but not deeds, and businesses but not statutes of incorporation,” he says. “Without these essential representations, they have not been able to produce sufficient capital to make their domestic capitalism work.”

In Manila, one way the poor obtain funds is through a method called “five-six.” You borrow 5,000 pesos from a lender who trolls the alleyways and pay back 6,000 pesos within two months, in installments of 100 pesos a day. Bernadette Ubaldo, who squats with her family in a shack along a waterway not far from the Manila airport, borrowed from a five-six lender to buy a used refrigerator. “Sometimes we do five-six for food,” she says sheepishly.

If you live in the U.S. or the U.K., you can take recorded deeds for granted; the notion of enforceable rights to real estate goes back to feudal times. On that foundation of ownership is built a huge edifice of capital that includes trillions of dollars in mortgage debt and trillions in real estate equity. Contrast that with the many parts of the world, from Mexico to Russia, where control of land has in the past century lurched from aristocrats to government confiscators to peasant squatters. It is likely, though, that basic property ownership early on underpinned economic growth. Nobel Prize-winning economic historian Douglass C. North asserts that the development of enforceable property rights was critical to mankind’s move from hunter-gatherer to agricultural societies about 10,000 years ago.

What passes for property law in the Third World would give shudders to any mortgage lender. Consider the case of Rey Estillore, 60, who taught biological science at Manila’s University of the East for 20 years. In 1993, one month after Estillore moved in to the simple home he’d built in Veteran’s Village, a longtime squatter zone in Quezon City set aside for families of those who fought in World War II, a woman showed up claiming she owned his lot.

“I did some research on this before coming here, and I found out her claim was fraudulent,” he says, sitting in the front room of his spartan home. “There are unscrupulous people who have connections within the bureaus and get spurious titles.” The court case has so far cost him $2,500, and that’s with legal help from friends at minimal or no charge. In the meantime, Estillore tries to scrape out a living in the printing business, with 1960-era presses that can’t compete with more modern machinery. Without land to use as collateral, he can’t afford better.

Scratch the surface and some 45 million of Estillore’s 76 million countrymen probably have a similar story to tell. Philippine President Joseph “Erap” Estrada, who ran for office with the slogan “Erap para sa Mahirap“–Erap for the poor–realized previous administrations’ efforts to alleviate poverty hadn’t worked. So his government brought in De Soto and his team. Their findings: The country’s legal and administrative systems force about 60% of Filipinos to hold their real estate assets outside the law. That translates into an estimated $133 billion in dead capital in the country–assets incapable of being used as collateral, mortgaged or easily traded.

De Soto’s think tank is now working on legislation to streamline, among other things, the land title process while addressing the plight of millions of squatters, a myriad of government-established and private settlements and the complex history of Filipino property rights. They hope to have the laws ready to go in two years.

Change will come more slowly in Egypt. Zein El Abdeen, a 37-year-old Cairo taxi driver, lives with his wife and 9-month-old daughter, his parents, grandmother and his two sisters in a 900-square-foot home where his father has squatted for 40 years. The government has allowed El Abdeen and his neighbors to live on state-owned land (it belongs to the Ministry of Endowment), but has never granted them official recognition. “We’re all aware of the bad part about living as we do,” says El Abdeen. “At any moment the ministry could demand that we vacate this area.”

El Abdeen dreams of opening a small factory to make plastic dishes. “But I need $1,500 to start, and I don’t have anyone to lend me the money,” he laments. “My father’s home is worth around $35,000, but unfortunately he doesn’t have papers, and no one will accept it as a guarantee.”

De Soto’s team, along with the Egyptian Center for Economic Studies, found that to acquire and legally register a lot on state-owned desert land in Egypt requires dealing with 31 public and private agencies, and red tape that can last from 5 to 14 years. No wonder 85% of Egyptians live in homes without functioning property titles.

Then there’s Russia, where the very idea of middle-class property ownership is foreign. Plots of land are registered in one office, buildings in another. Meanwhile, to get a bank loan, one must put up 150% -200% of the face value of the loan in collateral, plus get three guarantors with good incomes. On top of that, it takes two months for the bank to process; interest rates are currently around 45%. But the cost of obtaining documents, presenting a business plan and getting everything notarized in addition to the other requirements make such loans out of the question for many small entrepreneurs.

Anna Kostrova, 30, is a born entrepreneur. Near her home in Dzerzhinsk, Nizhny Novgorod (250 miles northeast of Moscow), she ran akiosk near the bus stop selling chewing gum, cigarettes and candies when she was 25. After she got married and had two children, she and her husband decided to rent a small cafeteria. They were able to borrow money from the bank to get it started, but that was before the 1998 crisis. With her assets devalued she couldn’t go back to the bank for the loan she wanted for a soda dispensing machine. Were it not for the assistance of a local microlending organization, Vozmozhnost, Kostrova would not have been able to expand her business. “I have a lot of plans to materialize,” she says, thankful that she has a financing alternative.

Microlending–disbursing working capital in tiny doses to small businesses and solo proprietors–is now all the rage at the World Bank and other antipoverty agencies. But a well-entrenched system of deeds and mortgages would make this specially designed lending a lot more meaningful.

Stephan Schmidheiny, a billionaire Swiss philanthropist whose Latin America-focused Avina foundation has funded De Soto, says as much: “An important part of the work we do in sustainable development and entrepreneurial education is the framework. I found Hernando’s approach the most convincing of any. The whole world talks about poverty alleviation, but very few have a practical idea on how to do it. He has.”

DeSoto figures only 25 of the world’s 207 countries are reaping the benefits of having a contractual, urban society. In the rest, the people congregate, but they lack a legal basis for exchange. “It’s the industrial revolution happening 150 years later,” he says. Think of it: It’s not so much the lack of capitalist ethos that impoverishes the people of Peru or Madagascar, but the lack of durable capital that can be traded back and forth. Absent that basis for capital markets, the billions of dollars of capital showered on the world’s poor by international agencies is like seed falling on barren ground.

A side effect of granting formal title to the poor’s assets is a boost to government coffers. In Peru 276,000 extralegal entrepreneurs recorded their businesses voluntarily from 1991 to 1994. Over that period, the tax revenue from the formerly extralegal businesses was $1.2 billion. But the majority of the informal sector isn’t staying outside the law simply to avoid paying taxes. The truth is, doing business outside the law presents all kinds of added costs. In Peru 15% of gross income in extralegal manufacturing is paid out in bribes, says De Soto.

As it stands now, De Soto’s approach is promising but not proven. In Peru only a small percentage of the country’s informal sector has new land titles. In Haiti, where his team began work in 1997, the package of laws they designed still awaits passage by the Congress. In Egypt, where De Soto began in 1998 and has 12 Peruvians and 30 Egyptians at work, the detailed assessment of the existing property and legal situation is under way; the Philippines is at an earlier stage of assessment.

The true test of his ideas will come after they’ve been tried in a variety of developing nations. If he can help alleviate poverty through legal reform and properly titling the slums of Latin America, an Islamic country, an Asian ex-colony and a former communist nation, De Soto will have truly proven his theory. And the Third World will owe him a big debt of gratitude.